L&T Management’s ‘Opportunistic’ Move Ahead Of Listing Of Subsidiaries

L&T management avails of stock options; IiAS says the timing is questionable.

Inside a L&T Factory (Photographer: Santosh Verma/Bloomberg)
Inside a L&T Factory (Photographer: Santosh Verma/Bloomberg)

L&T’s executive directors have generously issued themselves stock options of subsidiary companies at face value, before these companies’ went public, says proxy and governance advisory firm IiAS. And it’s the manner and timing of these issuances that have led IiAS to question the management’s governance practices, and the checks and balances the company has in place.

Larsen & Toubro Ltd. (L&T) decided to list two of its 121 subsidiaries in 2016 – L&T Infotech Ltd. and L&T Technology Services Ltd. In the run up to the listings, members of L&T’s management team were issued stock options in the two subsidiaries. By doing so, L&T’s management has made the most of the opportunity, proxy advisory firm IiAS says in a recent report.

Issuance Of Stock Options

IiAS points out Infotech has issued a total of 4.9 million options (based on available data) at face value. The notional gain (based on recent current market prices, and which will occur over the vesting period) aggregates to over Rs 310 crore. Technology Services issued 4.15 million stock options at face value. In this case, the notional gain (based on the IPO upper band price, and which will occur over the vesting period) aggregates to Rs 360 crore.

Source: IiAS Report [1]
Source: IiAS Report [1]

Stock options serve as a good measure for long-term incentives, says IiAS. By stipulating conditions of grant, vesting and exercise, stock options can help link pay with price performance and therefore, align management and shareholder interests, the reports added.

However, in L&T’s case, IiAS raises five issues with regards to the grant of options.

Responsibilities As Part Of The Holdco Board

Three of L&T’s board members (AM Naik, SN Subrahmanyan, and R Shankar Raman) have received stock options from Infotech and/or Technology Services. Both these companies were, and continue to remain, part of the L&T group. Therefore, as board members of L&T, they are already responsible for the growth of these businesses.

Do they need to be rewarded separately just because these businesses are getting listed?

IiAS believes not – especially since all three executives draw remuneration from L&T, which the advisory firm believes, is commensurate with the size and performance of the consolidated entity.

Source: IiAS Report [2]
Source: IiAS Report [2]

Remuneration Committee Composition

IiAS notes that the Nomination and Remuneration Committees of both Infotech and Technology Services include members of the L&T board – those that have received the stock options.

Source: IiAS Report [3]
Source: IiAS Report [3]

Generous Rewards

The rewards have been generous, says IiAS in its report. In the case of Infotech, 35 percent of the ESOPs granted have been to the board and 19 percent of the total pool has been granted to the non-executive directors belonging to the L&T board. In the case of Technology Services, 53 percent of the total pool has been granted to its board and 36 percent of the total pool has been granted to L&T’s board members.

IiAS says it looks at issuance of stock options at deep discounts as deferred compensation. In both these cases, though, the stock options are a ‘self-awarded’ reward. Take the case of Infotech where the IPO price was Rs 710 while the stock closed on 21 September 2016 at Rs. 637.75. Investors in the IPO are currently losing money, while Infotech board’s options, including those granted to L&T’s executive directors, are well in-the-money.

Timing Of The Grant

IiAS goes on to say that the timing of the Technology Services grant should also raise eyebrows. These stock options were issued between the filing of the draft red herring prospectus (DRHP) and the red herring prospectus (RHP). Between the DRHP and the RHP, companies would typically have estimated the market appetite for the equity as well as arrived at a broad understanding of the price range at which the book-building process will close. Issuing stock options this close to listing, at face value, is assured money, irrespective of what the vesting and exercise periods are.


IiAS also raises concerns regarding disclosures on stock options. Until the RHPs were filed, there were no available disclosures on the stock options being granted to L&T’s board members from subsidiaries. It’s fair to assume that L&T’s executive directors have been given stock options in other L&T subsidiaries as well, IiAS notes. How do shareholders then vote on overall compensation of L&T’s executive directors, if material components of the remuneration structure are not being disclosed?

L&T is a constituent of the major stock indices in India and has garnered respect for being one of India’s largest professionally managed conglomerates. This episode, however, shows that L&T’s executive directors behaved opportunistically, IiAS says as it raises questions on the company’s governance quality and the checks and balances it has in place.

[1] Fair value of stock options: Rs. 387; Market price = Closing price on 21-Sep-2016; Vesting period = 5 years Notional gain = Total no. of options granted x (Market price – Exercise price); the gains will occur over the vesting period. The notional gain for AM Naik mentioned in the above table is the result of accumulation of stock options granted from 2002 till the time of the RHP. Between 2002 and 2011, AM Naik was granted 1.8 mn stock options at face value under an earlier ESOP 2000 scheme. The management has clarified that exercise date for these options was fixed starting from 2015, since the IPO was planned around this time. Out of this pool, he has exercised 871,875 options and the remaining 928,125 options were outstanding on the date of Infotech’s RHP. Under ESOP 2015 Scheme, he was granted an additional 0.3 mn stock options at face value between the filing of the DRHP and the RHP.

[2] Fair value of stock options: Not disclosed; IPO Price refers to the Upper Band of the IPO; Vesting period = 5 years Notional gain = No. of options x (IPO price – Exercise price); the gains will occur over the vesting period.

[3] M M Chitale has been on L&T’s board for 12 years. While the company continues to classify him as an Independent Director, IiAS believes he is non-independent given his long association with the L&T group.